Kansas City Southern (KSU) Q3 2018 Earnings Conference Call Transcript

Kansas City Southern (NYSE: KSU)Q3 2018 Earnings Conference CallOctober 19, 2018, 8:45 a.m. ET

Contents:

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  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings and welcome to the Kansas City Southern third quarter 2018 earnings call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press * 0 on your telephone keypad. As a reminder, this conference is being recorded.

This presentation includes statements concerning potential future events involving the company, which could materially differ from events that could actually occur. Differences could be caused by a number of factors, including those factors identified in the risk factor section of the company’s form 10-K for the year ended December 31st, 2017 filed with the SEC. The company is not obligated to update any forward-looking statements in this presentation to reflect future events or developments. All reconciliations to GAAP can be found on the KCS website, www.kcsouthern.com.

It is now my pleasure to introduce your host, Pat Ottensmeyer, President and Chief Executive Officer for Kansas City Southern. Mr. Ottensmeyer, please go ahead.

Patrick J. OttensmeyerPresident and Chief Executive Officer

Okay. Thank you and good morning, everyone. Welcome to our third quarter earnings call. I’ll start with a brief comment on slide four, introduction of today’s presenters. I think you are very familiar with most of us. I will acknowledge the addition of Mike Naatz, our, as of October 1st, Executive Vice President and Chief Marketing Officer.

I think most of you saw the press release on September 10th announcing the change in our lineup here with Mike coming over to the Chief Marketing Officer role and Brian Hancock moving into the job previously held by Mike with a rebranding of Executive Vice President and Chief Innovation Officer. I’m happy to talk about that in the Q&A session. For purposes of today’s discussion and presentation, Brian will handle all of the sales and marketing commentary on the call today since he was in that job for the entire third quarter, but you will be hearing more from Mike going forward.

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Moving to slide five, just a quick recap of the results for the quarter, we had record revenue for any quarter in the third quarter of this year with an increase of 6% over last year on 4% volume growth. Brian will talk about some of the growth drivers in his commentary, but we saw a number of our oversized growth opportunities continue to hit full stride in the quarter and feel very good about the condition of the business in a number of those areas.

Third quarter operating ratio reported at 62%. Adjusting for some items, specifically the flood recovery in the third quarter from Hurricane Harvey last year, which Mike Upchurch will cover in more detail, our operating ratio was 63.4%, which was an improvement of a full point over last year. Third quarter earnings per share reported of $1.70, again, adjusted diluted earnings per share of $1.57, which was an increase of 16% from the prior year.

This shouldn’t be a surprise to anyone. I think most of you have done the math and have concluded that our volume guidance that we have given in the second quarter of mid-single-digits is going to be hard to achieve based on our — I think the guidance was gave was 3% to 4% at the end of the second quarter, given the results for the third quarter and the outlook for the rest of the year, we are now shifting that to low single-digit year over year volume growth for the full year of 2018.

I’ll remind you that a couple of important drivers to our revenue guidance being brought down over the course of the year was the delay in the start-up of some crude oil moves we thought would start maybe as early as the first quarter of this year, which didn’t materialize until much later, but it is moving and contributing to our growth from this point forward. And then the second factor was service-related issues, which Jeff will get into for some detail here, that have cost us some opportunities to grow in the second and third quarter.

So, if you look at this on the surface, it’s hard to feel bad about our performance, record revenues, operating ratio improvement of 1% over the last year on an adjusted basis and earnings-per-share growth of 16% year over year. But our performance this quarter did not meet our own expectations and some of the expectations that we articulated earlier in the year. We will get better. Our service issues are we’re seeing improvement every day. We’re getting a little better, the inventories and metrics are improving. Jeff will get into that in greater detail. I’ll turn the mic over to Jeff right now.

Jeff SongerExecutive Vice President and Chief Operating Officer

Okay. Thank you, Pat and good morning. Starting with the review of operating metrics for the quarter on slide seven, overall velocity in dwell saw significant impacts related to congestion in our border region.

While Houston congestion eased at the start of the quarter, we were not able to work off the backlog of traffic that built in Mexico during that time, which led to elevated volumes entering peak season. This residual excess inventory accompanied by substantial year over year growth and cross-border traffic of 13% and 20% in quarters two and three, respectively, strained our operation in the region.

Excessive dwell in our Monterrey and Sanchez terminals was the most pronounced during the quarter. Expanding upon these terminals, Monterrey is a high-volume terminal with significant local daily switching demand across a large number of customers. Elevated inventories have been slow to work off due to the inherent complexity of this operation. Our long-term operating plan for this area is to move some of the switching activity from Monterrey into Sanchez, where we will be able to handle the increasing volumes more efficiently.

We also experienced some growing pains this quarter associated with the new Sanchez yard switching operation and newly expanded mechanical working facility. As congestion eases, we should continue to gain efficiencies from our investment in Sanchez and our continued work with cross-border customs and international crew processes. Estimated cost due to the congestion of approximately $7 million during the quarter related primarily to increased equipment cost, labor, and overtime.

Turning to slide eight, expanding on service recovery efforts, this chart reflects our Mexico cars’ on line trend over the last several months. As indicated in earlier comments, events earlier in the year led to significant inventories, primarily in Northern Mexico. However, as shown here, the total number of cars on line in Mexico has reduced significantly from peak levels. Network velocity has shown steady improvement over the past few weeks and dwell has moderated from highs we saw in the early September timeframe.

Additional actions taken to restore service include adding resources to Northern Mexico. We are leasing 30 additional locomotives in the short-term and have temporarily relocated crews into the region. We have implemented some new service plans in Monterrey terminal and have worked with the largest customers to right size some of their equipment. We continue to work constructively with our interchange partners to ensure system fluidity.

While we will see pressure on performance metrics in Q4, as we continue to work down overall inventories, we believe these metrics are heading in the right direction and we expect to see more normalized levels in the next few weeks. Other comments for the quarter include an update on PTC.

I’m happy to announce that all of our PTC-required subdivisions are in revenue service and we are turning our focus toward interoperability. I want to recognize the entire team for their outstanding work with PTC, which has had very little operational impact during the past 12 months of revenue service implementation.

Additionally, as mentioned last quarter, we are on pace to start receiving the first of 50 new locomotives in January. While this will provide an overall enhancement to our road fleet with more reliable, more fuel-efficient units, we continue to right size overall fleet with the disposition of 33 low horsepower and switching units.

While it has been a challenging quarter, I believe our management team, recent and ongoing investments continue process improvements, relationship within our change partners all remain healthy and position us to capitalize on our unique franchise moving forward.

I will now turn the presentation over to Brian.

Brian HancockExecutive Vice President and Chief Innovation Officer

Thank you, Jeff, and good morning, everyone. I’ll start my comments on page 10, where you can see third quarter revenue was up 6% on a 4% volume growth despite continued headwinds from the closing of a large utility customer facility in Texas. In the third quarter, we continued to see strong growth in cross-border car loads and revenue, benefiting from key areas such as refined products, automotive, and cross-border intermodal.

However, as Jeff discussed during the quarter, we also experienced congestion in the North Mexico region of our network to partially offset some of the expected year over year volume benefit from Hurricane Harvey in Q3 of 2017.

During the quarter, our revenue per unit grew 2% despite mix pressure from the loss of the long-haul utility coal business and unfavorable FX impact. Core pricing came in at 3.7%, benefiting from an acceleration in contract renewal rates secured during the first half of 2018 when most of our renewal activity occurs.

The chemical and petroleum business unit grew revenue growth of 17%, primarily driven by petroleum and plastics, with both units benefiting from favorable comps due to Hurricane Harvey. Additionally, petroleum revenue grew 36%, driven by strength in our southbound volumes of refined products related to Mexico energy reform.

In Q3, Mexican energy reform carloads and revenue grew 164% and 123%, respectively, and we included an update on this important and growing business segment in our appendix. Revenue from our industrial and consumer business unit was flat year over year.

This business unit benefited from strong forest products and appliance revenues due to the tightening truck capacity and increased brown paper demand, but was offset by lower metals revenue, where length of volumes were negatively impacted by a shift in customer sourcing trends. This segment was also negatively impacted by the previously mentioned congestion at the border.

Another segment that was impacted was our agricultural mineral business. In this segment, revenue was flat year over year with revenue per unit offsetting volume declines. Our food products continue to be impacted by our shifts in sourcing and a temporary customer plant outage. Similar to last quarter, energy’s revenue decline of 2% was driven by a previously announced closure of a power generation facility in Texas and by frack sand sourcing changes.

These declines were partially offset by higher volume and pricing in our crude oil business driven by increased production in Canada with increased rail utilization. Intermodal revenue increased 8% with mixed performance by lane. Both US, domestic, and cross-border businesses saw solid performance as we continue to benefit from truck conversion as well as favorable comps from Q3 2017.

Similar to last quarter, this growth was partially offset by a 9% year over year decline in Lazaro intermodal volume. As I’ll discuss on slide 12, we are seeing some early positive signs from the actions we have taken to restore our Lazaro Cardenas volumes.

Revenue from our automotive business was up 8% over prior year. Volumes increased due to higher carry over inventory and increase in plant production and increase in Lazaro Cardenas import volumes and favorable comps due to the 2017 Hurricane Harvey interruptions. Our business also saw a negative impact from the border congestion and continued industry network congestion that resulted in equipment availability issues in North America.

On slide 11 and in support of Jeff’s comment regarding congestion of the border, we wanted to provide a perspective on the increase of volume in our cross-border business. As we can see year over year, cross-border volume increased 20% in the third quarter. Over the last few years, our mix of shipments has shifted away from our domestic coal and more toward cross-border refined products, automotive, and intermodal business. We’ll continue to see these changes impact our business over the next few years.

Now to slide 12, where we provide an outlook for the fourth quarter 2018 for each of the business segments. As Pat mentioned, all full-year volume outlook is for low single-digit year over year growth. Overall demand continues to be robust and we are working with our customers to create innovative solutions for their growing future needs.

Starting with chemical and petroleum, Mexico Energy Reform continues to be a significant focus and unique opportunity for KCS. We expect for volume growth for refined products to continue at an accelerated pace for the next few years as additional storage capacity comes on line. Additionally, we expect plastics to grow in the second half of 2018 due to increased demand.

We also expect to see continuing solid growth in intermodal cross-border in US domestic lanes. As was discussed last quarter, we are closely monitoring our Lazaro Cardenas volumes and are seeing early positive trends during the peak season as additional trucking regulations are implemented in Mexico and as our customers continue to evaluate and take advantage of the short-term volume-based pricing strategy.

Significant congestion at the Port of Manzanillo is also helping to bolster our Lazaro volumes. We will see solid performance in our automotive business with growth slightly ahead of most third-party estimates from Mexico production. In addition to increasing production in Mexico, our growth may benefit from market share gains with some of our biggest customers. As congestion eases and the new equipment continues to grow online, we expect to see continued growth in our automotive business.

Our industrial and consumer business units should continue to benefit from strong demand and tight truck capacity, particularly in the paper and appliance businesses. However, our metal segment will continue to see unfavorable impacts of shifts and sourcing strategies and trade developments. This segment will also see the largest benefit as congestion eases and a normal operating environment returns in Northern Mexico. We expect our ag and min volumes to be slightly up in Q4, with steady demand in both grain and food products, as well as easing in the North Mexico congestion.

Our energy business will be down during the fourth quarter as it continues to be impacted by the closing of the facility in Texas and as changes in fracks and sourcing continue. However, we do expect continued growth in Canadian crude with volumes similar to the level that we moved in Q3 as well as short-term opportunity in the Permian Basin crude.

With that, I’ll turn the call over to our CFO, Mike Upchurch.

Michael UpchurchExecutive Vice President and Chief Financial Officer

Thanks, Brian and good morning. I’ll start my comments on slide 14. Third quarter of 2018 revenues were $699 million, growing 6% over the third quarter of 2017. The depreciating peso negatively impacted revenue by $10 million while fuel surcharge revenues increased $25 million over the third quarter of 2017. Reported operating ratio of 62% represents a 240-basis point improvement over the third quarter of 2017.

Included in the third quarter 2018 reported operating ratio is a $9.4 million gain on a partial settlement of our Hurricane Harvey claim that impacted us during the third quarter of 2017. Adjusted operating ratio improved 100 basis points, despite a challenging operating environment that added approximately $7 million in extra expense due to network congestion. Incremental margins excluding the insurance gain were approximately 50%.

Reported EPS was $1.70, a 38% over third quarter 2017. On an adjusted basis, EPS was $1.57, an increase of 16% over the third quarter of 2017. Our adjusted effective tax rate was 29%, 1 percentage point lower than our guidance of 30. We now expect our adjusted effective tax rate to be 29% for the year 2018 and into 2019.

The lower effective tax rate is primarily due to reduction or guilty tax expense as the treasury department has indicated new regulations fixing the foreign tax credit issues forthcoming in the next few weeks that will partially remediate the negative implication of the guilty tax to KCS.

During the quarter, we also reported a $16.6 million one-time tax benefit due primarily to a reduction of the provisional repatriation liability we recorded at the end of 2017 that resulted from new interpretations and treasury department regulations issued during the third quarter that clarified the amount of repatriation tax due.

As the nature of the benefit is one-time only, we recorded this as a credit in adjusted to reported EPS. A complete reconciliation of reported to adjusted EPS is on page 24 in the appendix. Finally, average outstanding shares for the third quarter were 102.1 million, lower than the 104.7 million average outstanding shares for the third quarter a year ago. A reduction in shares outstanding is reflective of repurchasing our common stock. Additional details on our income statement are included in slide 23 in the appendix.

Moving to slide 15, adjusted operating expenses, which excludes the $9.4 million gain we recorded in the third quarter in the partial settlement of Hurricane Harvey damages increased 5%. Fuel prices increased $16 million. Network congestion drove $7 million of incremental expense in the quarter. Depreciation increased $6 million, primarily from PTC in-servicing, wage inflation and increased headcount contributed to $6 million of year over year expenses and offsetting these increases were lower incentive compensation of $11 million and FX impact of $7 million.

Turning to slide 16, compensation and benefits expense decrease 4 percentage points, largely the result of year over year declines in incentive compensation expense of $11 million. Partially offsetting that decline was wage inflation and a 1% increase in FTE, combining for a $6 million increase in comp and benefits expense. Network congestion also increased our compensation and benefits expense by approximately $2 million due to higher accrued costs and overtime. Finally, FX reduced compensation expenses by $2 million.

Turning to slide 17, fuel expense increased 17% due to an increase in fuel prices in the US by 30% and in Mexico by 13%. Foreign exchange contributed to a $3 million reduction in fuel expense.

Turning to slide 18, equipment expenses increased $2 million or 7%. Network congestion contributed to an incremental $4 million of car hire expenses in the quarter. Partially offsetting the car hire increases are continued lower equipment lease expenses of $2 million. Purchase services increased $7 million or 14%. Repairs and maintenance equipment increased $4 million due to lower billings to other equipment owners that are generally recorded as credits.

Partially offsetting that repair and maintenance billings were savings in the materials and other line items. Again, network congestion caused us to detour some traffic to other real partners, which increased expenses by $1 million.

Turning to slide 19, we continue to believe our best use of capital is to invest in our growth opportunities. For 2018, we are now projecting capital to be on the lower end of our $530 million to $550 million guidance. This will be the third year in a row of reduced CapEx in both absolute dollars and as a percentage of revenue.

While our capital budget for 2019 has not been finalized, we do currently expect to see an increase in capital due to the purchase of 50 new locomotives. Excluding the locomotive purchases, the remainder of our CapEx is expected to be flat to slightly down from 2018 levels. We also continue to evaluate investments in growth opportunities, particularly in Mexico as the refined product market continues to show very promising growth.

During the quarter, we repurchased 472,000 shares of our common stock and have now completed approximately $420 million of the $800 million share repurchase program approved by our board in August of 2017.

Combined with dividends of the last year, we have provided our shareholders well over a half-billion in returned capital. Finally, we continue to be very comfortable with our capital structure. We now own 77% of our equipment, stemming from our 7-year effort to purchase leased equipment. During this time, we have purchased over $1 billion of leased equipment, resulting in an approximate 250 basis point improvement in OR and an approximate $40 million improvement in cash and net P&L benefit. We expect to enjoy an industry — we could continue to enjoy an industry-best weighted average interest rate of 3.96% and have credit metrics that are better than the peer group.

With that, I’ll turn the call back over to Pat.

Patrick J. OttensmeyerPresident and Chief Executive Officer

Okay. Thank you, Mike. All right. I’ll close with a few comments here and then open up for questions. First, I’d like to say our core business continues to be strong. As Brian said in his comments, demand in most of our business units is robust. Economic outlook is positive in both the US and Mexico and we are seeing and realizing some of the oversized growth opportunities that we’ve been talking about for the last few quarters, specifically the growth and refined products and continued growth in intermodal and automotive.

Secondly, at this moment, our service is not meeting our customers nor our own expectations and our operational efficiency is not where it needs to be to handle all of the growth that we see in front of us. We will get better. Jeff talked in his comments about the recent trends, the assets, the resources we’re putting on this problem. Mike mentioned the 50 new locomotives we’re buying that we will take delivery of in 2019.

I have tremendous confidence in the team. They’re focused. They’re working very, very hard to get us through this and get us on our feet and we are getting better almost every day. I think we can see with the recent trends that we are improving. Don’t lose sight of the fact in slide 11 that Brian showed we’ve had really exceptional growth in cross-border volumes and revenues for the last two quarters. So, some of this congestion is a function of the growth we’re experiencing at the quarter. Again, I’ll just reiterate. We will get this fixed and we will get better.

Third, some of the so-called storm clouds that have created uncertainty and darkened our skies for the last couple of years are dissipating. The renegotiation of NAFTA and the signing of the new US MCA still have some work to do there with the congressional approvals in all three countries, but based on what we have seen, it looks like a good agreement.

Some things need to be worked through. I’d say specifically the steel and aluminum tariffs that have not been removed and released probably is the biggest question and obstacle to the congressional approval process, but I’m very confident that will move forward and remove that uncertainty. Certainly, the presence of an agreement with the three countries is a very good thing and we happen to think this agreement is worth a good outcome.

Then the transition in the Mexican election — I looked back on my comments at the end of the second quarter, don’t really have too much more to say. We continue to be pleased by the messaging that is coming out of the new administration. We continue to engage with new government officials as we get closer to the December 1st transition date. Again, most of the messaging, most of the signals we’ve gotten are positive and encouraging that we will not see any major shift in foreign relations or economic policy a few weeks ago. We think at this point, that all looks to be significantly less of a risk and an uncertainty than it was in the past.

Finally, I’ll just close with our long-term growth fundamentals remain very strong. We feel very confident. We have good visibility in some of the oversized growth areas that we’ve talked about — refined products, plastics, intermodal and automotive and feel those fundamentals have remained unchanged and very strong for the years ahead.

With that, I will open up the call for questions.

Questions and Answers:

Operator

Thank you. We’ll now be conducting the question and answer session. If you’d like to ask a question, please press *1 on your telephone keypad and a confirmation tone will indicate your line is in the question queue. You may press *2 if you’d like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Due to the number of participants on this morning’s call, management will limit your question to one primary question and one follow-up question.

Our first question today comes from the line of Allison Landry with Credit Suisse.

Allison LandryCredit Suisse — Analyst

Good morning. So, there hasn’t really been too much attention on KSU from a precision railroading perspective. I just wanted to understand — is that something you think about or are there maybe elements you’re considering given some of the congestion you’re experiencing? I wanted to understand or maybe if you could, outline some of the reasons why it would work or conversely it would not work. I would like to get your thoughts on that.

Patrick J. OttensmeyerPresident and Chief Executive Officer

Allison, absolutely. There certainly are elements of the precision scheduled railroading methodology we think makes sense. A lot of these fall back to things like lean processes, trip plan compliance, improved asset utilization, discipline. We are working through all of those things on an ongoing basis and we think they can be helpful to getting us through the service issues and the congestion issues we’re experiencing now.

We’re also paying close attention to what’s going on with our interchange partner, Union Pacific. Obviously, they are implementing their own version of precision scheduled railroading with the unified 2020 plan. The magnitude and degree of our interchange with UP is really going to dictate that we cooperate and in some cases probably follow their lead on some changes in the operating philosophy. We’re staying very close to that.

If it makes sense, if there are elements of the plan that we think can improve our efficiency and our interchange with UP, we’re going to be very open-minded to adopting and integrating those principles. I don’t know, Jeff, did you have anything more to add?

Jeff SongerExecutive Vice President and Chief Operating Officer

Yeah. So, Pat touched on a couple of those keys, really. If you look at the congestion now, it’s inventory. So, certainly asset utilization, turning those cars faster, working constructively with customers to right-size fleets if you will, for me, there’s certainly an opportunity for us in that one specific area as well as others. We were looking across the board.

We’ve seen some good efforts over the last couple of years with fuel efficiencies, focusing in on labor productivity. Volume this quarter of 4% on labor of 1% increase — there are some efficiencies being gained there, but I think we can certainly go farther. We are certainly working, as Pat mentioned, with interchange partners to understand how that may impact us, understand how that might shift some of our own schedules and lean things up, to be honest.

Allison LandryCredit Suisse — Analyst

Okay. Is there anything with the labor agreements in Mexico or the border crossing that would prevent you guys from implementing this in terms of the cross-border or the Mexico business.

Jeff SongerExecutive Vice President and Chief Operating Officer

No, nothing unique to Mexico. We’ve talked in the past about elongated hiring times, but looking to just right-size and simplify our network a bit, but there’s nothing inherent to Mexico that should be any different as to how we look at that in US.

Allison LandryCredit Suisse — Analyst

Okay. Really quickly, in terms of the cross-border volume growth in Q3, how much do you think the car cycle times and what not hurt growth and is that something we should expect you to persist in Q4?

Brian HancockExecutive Vice President and Chief Innovation Officer

Yeah, Allison, this is Brian. I would say that certainly, the longer cycle times did impact us during the quarter. Over the last few weeks, we’ve been getting much better. I would tell you much of the focus we have with Jeff’s team is making sure we have the priorities as we start to turn these cars specifically in refined products, grain, and automotive. Those are the big three where car turn and utilization is important.

I would say we’ve been in lockstep with our customers as we’ve gotten through this congestion, but it’s certainly critical, but I think we’re certainly starting to see the light at the end of the tunnel and we feel like that’s certainly going to be a key thing for us to focus on in the future.

Patrick J. OttensmeyerPresident and Chief Executive Officer

Allison, just a quick reminder, headline growth on cross-border for volume and revenue given the fact that we had the hurricane in 2017.

Allison LandryCredit Suisse — Analyst

Got it. Thank you, guys.

Operator

The next question is from the line of Tom Wadewitz with UBS. Please go ahead with your question.

Tom WadewtizUBS — Analyst

Good morning. I wanted to ask a question on the capacity and the operating side. It seems like you’ve made good investments over time to position yourself to handle growth and you’ve been optimistic on seeing that growth come in, but you seem to run into some of these issues with congestion and so forth, whether it’s at the cross-border points or the Northern Mexico terminals.

I just wanted to see if you could give a sense of what gives you confidence in 2019 that you’ll be able to handle some of the growth that may come on if there are things that are different or just how you would look at that, what would give you confidence that you could handle the growth that may come on in ’19.

Jeff SongerExecutive Vice President and Chief Operating Officer

Yeah, Tom, this is Jeff. If we look at investments in cross-border, Sanchez is a great new facility for us. It’s added a lot of capacity. As I mentioned, the indicator for me this quarter has been the volume.

The graph I showed on slide eight there, I don’t want to dredge back in to Hurricane Harvey, but I wanted to show the trends in total inventories online and how that’s grown over the last several months. Jumping into peak season with the impacts we’ve seen for a good part of the year, some of those in our control, some out of our control has just really led to an elevated view, jumping off point, if you will, in the peak.

Then compounding that with the cross-border growth we’ve seen just created additional demand. So, starting off the network with Monterrey getting clean, with Sanchez getting clean — we really haven’t been able to do what we wanted to do in Sanchez yet, which has relieved some of the pressure and some of the volumes out of Monterrey.

So, as this congestion gets more clean, you’ll start seeing those operating shifts and our operating plan shifts to utilize new and more efficient capacity. In Sanchez specifically, we have international crews. Thus far, we’re running maybe three to four trains a day with international crews. We’ve got five crews certified. By the end of November, we’re targeting to have another five certified. That will continue to add capacity there at the bridge. We’ve got some new higher horsepower locomotives, as we mentioned, coming on here starting in January.

We continue to work with interchange partners, specifically UP on efficiencies at Laredo, also looking at the Matamoros Gateway, how we can expand and continue to utilize that for additional cross-border volume. So, I’m comfortable that capacity is there. As Mike mentioned, we’re still going to have a healthy CapEx for next year and we’re still focusing on these key areas to continue to add capacity where it’s at. That coupled with some of the simplification and some of the lean concepts that we’re working on.

Patrick J. OttensmeyerPresident and Chief Executive Officer

I just chime in. Go back and take a look at that slide that Jeff mentioned. Look at that trend from April to September. This was an issue that has been building really for six months and it’s going to take a while to get through it. We’re getting better every day, as I mentioned, and when we get through it and begin to see the benefits of some of the clearing out of the yards and some of the capacity that we’ve added, we’ve continued to add capacity at Sanchez every year, very confident that we’ll be able to handle the growth that we see for 2019 and beyond. The addition of the locomotives obviously will help as well.

Tom WadewtizUBS — Analyst

Okay. I appreciate that. What about the idea or the risk that you control your destiny, how you run, but you are affected a lot by UP. I guess on the Monterrey Yard comment, local traffic, you’re affected by customer actions as well. How much of a fact do you think the flow from UP and getting customers to change behavior, how much of the improvement is dependent on those two things.

Jeff SongerExecutive Vice President and Chief Operating Officer

From a customer view, I think again, I think we’ve learned a little bit coming out of congestion here working with our largest customers there to really try to right-size some of the equipment, we probably hold a little too much equipment for some of our main customers. Working with them to right-size equipment, we are also I don’t want to say partnering or working with customers as well on capacity in their own terminals. If you look at the Monterrey industry in general, it’s aged.

There’s probably not the capacity in general around the Monterrey or for a lot of customers, but we’re actively right now working in partnership with looking at their own terminals and how we collectively add capacity to the area. So, that’s certainly one positive and if I want to take a little bit of positive away from the congestion, some of the learnings and takeaways and really partnering and working more closely with the customers, that’s certainly ongoing right now.

UP, obviously, it’s a very important interchange partner for us. We continue to work constructively with them, as I say, they’re working with us on international crews in their own right, helping and assisting and working jointly with customs processes at Laredo. As I mentioned for me, the Matamoros-Brownsville Gateway remains important. We’re only crossing four to five trains there a day. There’s no reason that can’t have a similar capacity that we’ve got at Laredo.

I think all of the above — I think it’s healthy. I think the relationships and the interchange partners is all healthy. I think it’s mutually beneficial. A lot of that traffic, still a greater portion of the traffic over at Laredo is UP. There’s no reason they don’t want to continue to partner and work with us to get better.

Patrick J. OttensmeyerPresident and Chief Executive Officer

I think that’s really an important thing to emphasize is these are joint customers. So, they are equally important to our interchange partner in the north as they are to us. Then to circle back on the Matamoros so there’s more emphasis on that — Matamoros-Brownsville historically has always been — I’ll use a word that Lance Frtiz actually use — a bleed valve. It’s been sort of a safety valve. When things get congested, we use it to reroute traffic, to reduce congestion at the border. We are now engaged with UP to look at that more strategically.

The problem with the bleed valve strategy is you don’t build capacity for a longer-term. You tend to have higher cost. It’s something that comes and goes. It’s used an interim basis infrequently kind of in emergency circumstances. When we look at the growth that we have coming out of the Gulf, refined products is a great example, but it could also play into grain and automotive and other things. We’re going to need to completely rethink how we use that Brownsville-Matamoros Gateway.

It’s going to be a longer-term strategic part of the network for both of us. We need to make sure we’ve got the resources and the capacity. We’re going to spend money over the next three or four years on what we call the F-line, which is the route between Monterrey and Matamoros, to make sure it’s up to standard and has the capacity for the growth that we see. That longer-term, I think, will create a lot of efficiencies for both of us in the way we handle cross-border traffic.

Jeff SongerExecutive Vice President and Chief Operating Officer

I’d mention one other thing. We don’t talk a lot about FXC, but there is a project ongoing with FXC constructing the bypass around Monterrey. So, as well as we work with interchange partners, we’re doing the same in Mexico. That will give us the ability to reroute trains out and away from the most congested areas of Monterrey. So, we look for that bypass to be complete toward the end of next year. I think all railroads will focus on it. All railroads will continue to focus on the capacity side of things as well as the process improvement side.

Tom WadewtizUBS — Analyst

Great. Thank you.

Operator

The next question is from the line of Chris Wetherbee with Citi. Please proceed with your question.

Chris WetherbeeCitigroup — Analyst

Thanks, guys. Good morning. I wanted to start on the volume side to get some perspective from you, maybe not so much about ’18 and how you’re thinking the fourth quarter lays out based on the guidance you kind of get there. I guess as I look out into 2019, I wanted to get a sense — you have the coal issues potentially being lapsed. Is that something that we should continue to expect to be a drain on ’19?

Maybe talk a little bit specifically about how the refine products opportunities might ramp up next year. It sounds like you have a few of these facilities online. You have origination points on the Gulf Coast. I wanted to get a sense, maybe an early look at how things shape up for ’19.

Brian HancockExecutive Vice President and Chief Innovation Officer

Sure, Chris. This is Brian. First off, what I would say is when you think about refined products, that is certainly where a significant amount of our focus is. If you think about the facilities coming online, it’s not the facilities coming online. It’s the tank storage that’s coming online. So, you’ve already seen some increases there in the San Jose Iturbide area. You’ll see two additional tanks there. Then at our facility in San Luis Potosi, those will come online in the first quarter. We feel very comfortable that in those two particular spaces, we’ll have the additional storage.

There was also some construction that began earlier this year in the Salinas Victoria area. those will come on in the third quarter. That will be storage for the Monterrey area. I think overall we feel very comfortable that 2019 is going to continue to be a year where volumes will be strong. We’ll continue to work — it’s important for us to work with every single one of these groups to make sure the loading and unloading capacity is there so we can do it quickly.

Again, utilization of cars is a critical piece. When you think about the other pieces of the business, I would say we’re going to continue to see strong — it’s a very strong economy down in Mexico, so each one of our business units is finding success in their own right. I would say we’re going to continue to see volume increases as we move forward.

Michael UpchurchExecutive Vice President and Chief Financial Officer

Chris, this is Mike. Specific to your coal question, that has impacted our car loads and revenue by approximately 3 percentage points this year. We can’t wait to get to January 1 and lapse that negative comp.

Chris WetherbeeCitigroup — Analyst

That’s sort of what I figured. That’s helpful. I appreciate it. Maybe thinking on the cost side, Mike, you mentioned the incremental margins in the third quarter, which were quite good. I know there were probably some incentive comp dynamics moving around in the third quarter. I just wanted to get a sense maybe at how sustainable you feel that type of run rate is with the top line that you’re sort of expecting for the fourth quarter. Are there going to be some puts and takes maybe specifically on the incentive comps we need to think about in the fourth quarter? Is there anything else we should be looking at?

Patrick J. OttensmeyerPresident and Chief Executive Officer

Well, let me go back to the current quarter first. While we did see some favorable true up on incentive comp, that was because we had $7 million of incremental network expenses and we also had a fair amount of revenue in margin that ended up getting lost or deferred from the third quarter. So, generally, incentive comp, whether it moves up or down is more than offset by incremental margin.

But as we’re look in to 4Q, I would tell you slightly higher depreciation with the PTC in servicing on the company. Maybe it’s a couple million higher going into the fourth quarter. We did obviously record a credit in the third quarter to true up the first half of the year. We do expect a continuation of higher fuel costs and then Jeff mentioned some leased locomotives that we’re going to add to the fleet here in the fourth quarter. That will add a little over $1 million. Hopefully, those are the key puts and takes.

Chris WetherbeeCitigroup — Analyst

Okay. That’s really helpful. I appreciate the time this morning, guys.

Operator

The next question is from the line of Matt Russell with Goldman Sachs.

Matt RussellGoldman SachsAnalyst

Good morning. Thanks for taking my question. Switching gears a bit, it seems like you’re making some progress at Lazaro. Can you talk a little bit about whether that’s tied to the pricing rebates you were referencing on the last call. Is it still possible that we see that turn positive year over year in 4Q or early next year? Any updated guidance around that?

Jeff SongerExecutive Vice President and Chief Operating Officer

Yeah, Matt. I would say we’re very pleased with the results for Q3. When you think about what’s happening in Lazaro. There are a couple of dynamics. Certainly, our pricing led that off. I think people that were some of the smaller carriers took immediate beneficiary to that. What I would tell you as well is we’re also seeing a lot of congestion at the Port of Manzanillo, which is just north of our port. Some of that freight is now being diverted into Lazaro.

I think the fourth quarter, we’re prepared to handle what we believe to be a very good quarter. Whether we’re able to get all the volume that we would like to get is still to be played out. I think there are a couple of those big pieces. We have seen better fluidity there, certainly the congestion at Manzanillo. The pricing makes it able for customers to come back. I think what’s happening, at least from our perspective is people are looking at the ports in a more balanced fashion.

They’re not playing each other against one another because they realize all of the ports need to have capacity and fluidity. I think we’re seeing the benefit of that. We expect 2019 to be a year where people take advantage of that. I feel pretty comfortable that we took the right steps. Our timing couldn’t have been better and hopefully we’ll see the benefit of Q4 and Q1 as well as into next year.

Matt RussellGoldman SachsAnalyst

Great. That’s helpful. Just in terms of some of the initiatives, you were talking about working with your customers on improving capacity inventory. Have you considered or are you implementing stricter enforcement on demerge and detention? Any thoughts around that?

Brian HancockExecutive Vice President and Chief Innovation Officer

We certainly kind of can see what’s going on in the other railroads around those areas. For me, there are certain tools we have, first and foremost, working with customers to understand the overall benefits. While an individual customer may desire to have more cars online for their comfort, understanding and clarifying that has total system and network impacts.

That could, in theory, hurt them. Demerge is one tool, for sure. We have an active demerge program. We utilize that effectively. I think we will continue to use the tools that we have to make sure we’re incenting and really educating customers what’s the right level of equipment. How we get there, for me it’s more joint efforts. It’s more understanding and clarification. However, we have other tools in our toolbox.

Patrick J. OttensmeyerPresident and Chief Executive Officer

Probably a good example of other things that we’re thinking about to create the kind of efficiency, fluidity, the investment that we’re making in refined products, terminals in Mexico. The story behind that, those refined products tend to be loaded in unit train quantities in the US refineries. There just isn’t capacity in Mexico for unit train unloading.

So, we can congest our yards and we can handle this kind of lopsided out of balance supply chain where you load units on one side and you unload small quantities on the other side, congest our yard and our you are about demerge or we can actually use our financial wherewithal, work with our customers to create capacity to create more of a balanced supply chain where we load units and we unload units.

We have the same phenomenon in some of our grain locations. We have the same phenomenon in some of our steel locations. The demerge is a useful tool to make sure that we and the customers are following the discipline we need. Using our capital and working with our customers is not always going to be our capital, but working with our customers to create more capacity away from our yards or think differently about how we handle some of the flows of these products I think is a good long-term solution and it’s going to produce the benefits in terms of cycle time, improved cycle time, improved asset utilization, reduce congestion that we want to achieve longer-term.

Jeff SongerExecutive Vice President and Chief Operating Officer

Certainly. The only other thing I would add is if you look at just the Monterrey area, the capacity that’s been created at our customers’ facilities, brand new automotive facility in the past in Mexico, that wouldn’t have the capacity to handle hardly anything from a storage perspective. Now, with our help, those facilities are significantly larger and it allows us to be able to drop a train, pick a train, be able to do things we couldn’t do otherwise. The largest soybean facility in North America is now in Monterrey.

In the past, that facility would not have the capacity that it has, but again, with our help and design, we’re helping design these facilities. It’s now the ability they can store a couple of trains and that creates fluidity on the main line. I think what Pat said, what Jeff said, this is something that didn’t exist in Mexico, this mindset of creating capacity and logistics capacity at facilities really hasn’t existed and now you see these owners of the new buildings, they’re making those investments. We’re helping them do that in the correct way and I think we’re going to see long-term benefits from that.

Matt RussellGoldman SachsAnalyst

Understood. Thank you very much.

Operator

The next question is coming from the line of Bascome Majors with Susquehanna. Please proceed with your question.

Bascome MajorsSusquehanna International GroupAnalyst

Thanks for taking my question. Mike, I was hoping I could unpack some of your comments on the capital budget for 2019 a little bit. I believe you said kind of core CapEx, flat to maybe even slightly down. The 50 locomotives, I believe you’re also said you’re selling 33, so there will be a bit of an offset there. Can you help us size up incremental CapEx from that. A wide range is fine. I’m trying to think about what that might look like.

Michael UpchurchExecutive Vice President and Chief Financial Officer

Yeah. Let’s take the mystery out. The locomotive purchase will be about $140 million. The units that we’re going to sell are 70 vintage Super 7s. I wish we could get the kind of price we pay for a new one, but that’s going to be a pretty low number. Our net CapEx from locomotives is going to go up substantially. We haven’t bought any locomotives since 2015.

Bascome MajorsSusquehanna International GroupAnalyst

Okay. You kind of left the caveat in there about the project CapEx. Is it that we planned to spend on some of these destination terminal projects and we don’t know what that number is? Any kind of ballpark as to what that might look like if it comes through, realizing that that’s a good new story if that happens.

Michael UpchurchExecutive Vice President and Chief Financial Officer

Bascome, I would tell you at this point we don’t have any agreement with anybody else that would cause us to jump into a venture to build out new facilities, but we are having ongoing discussions with a number of different partners. We’re kind of looking at those facilities as let’s get them on our railroad and get them the opportunity to get the line haul revenue. It’s difficult sitting here today to know exactly whether or not we’ll spend any incremental cashflow on those terminals down in Mexico.

Bascome MajorsSusquehanna International GroupAnalyst

Understood. Maybe kind of tying it all together, it feels like this year kind of a couple of quarters of ratcheting down expectations has weighed on your multiple. As we look to next year, it looks like street revenues or something like high single-digit growth, low double-digit growth on EBIT, mid-teens, and EPS kind of 53% incremental margin. Is that something that gives you pause from where you sit today or if things go well, is that something you think the KSU franchise can achieve?

Michael UpchurchExecutive Vice President and Chief Financial Officer

I think that’s a backward way of asking for guidance for 2019. We’ll talk about 2019 more at the end of the fourth quarter. We’re in our budgeting process and working through whether the right assumptions in terms of network recovery/service recovery. We’ll have more to say about that in January.

Operator

Thank you. Our next question is from Amit Mehrotra with Deutsche Bank.

Amit MehrotraDeutsche BankAnalyst

I’m going to take another stab at that 2019 question. So, as we move from, I guess, ’18 to the ’19 CapEx is going up, maybe set by some of the service and congestion issues that hopefully abate or would likely abate. You have a long-term 50% incremental margin, EBIT margin target out there that you’ve talked about before.

It seems like with crude car loads doing what they’re doing, refined product car loads hopefully accelerating, lapsing of the headwind from coal, if you don’t achieve over 50% incremental margins in ’19, maybe you have to reassess the long-term target. Is that a fair way of articulating it or am I missing some of the moving parts?

Michael UpchurchExecutive Vice President and Chief Financial Officer

Yeah. Amit, this is Mike. I think this is a fair way to look at it. The first half of this year, we really didn’t have any volume growth and it’s really difficult to generate 50% incremental margins in that kind of an environment. You saw us do it here in the third quarter and rolling in to 2019 with negative comp dropping off on coal. We would certainly expect nice volume in revenue growth. I’m not going to comment on specific numbers, but our target will not be any different than it is today to generate 50% incremental margins in that kind of environment.

Amit MehrotraDeutsche BankAnalyst

Just on the energy side of the house, the crude growth was obviously very strong, maybe staggeringly strong, you could say, and I guess it makes sense given the crude coming out of Canada. Now, with the Cenovus volumes coming on line maybe over the next six months or so and CP getting a fair chunk of that, can you just talk about what the runway is in terms of crude car load growth and how well the company is capacitized to handle that growth next year?

Brian HancockExecutive Vice President and Chief Innovation Officer

Hi, Amit. This is Brian. We feel very good about what’s going on with crude by rail. Certainly, we’re working closely with our interchange partners. We feel very comfortable that we have the capacity necessary to do everything that we see in the future, everything that everyone else has spoken about that’s going to hit our line, we feel very comfortable about it. It’s a good business for us. We’re certainly going to continue to see it grow. It looks like here over the next year, year and a half. We’re very comfortable that we can handle.

Patrick J. OttensmeyerPresident and Chief Executive Officer

Just remember that none of that business goes cross-border or around Beaumont to Houston to Laredo route. So, to the extent that capacity has been freed up because of the reduction in our coal business, this is a really good fit for that part of our network.

Michael UpchurchExecutive Vice President and Chief Financial Officer

And the spreads are extremely wide right now, WCS to Mayan crude. So, it should certainly get us an opportunity, but there are other railroads that operate in that region as well.

Operator

Our next question is from the line of Ken Hoexter with Merrill Lynch. Please proceed with your question.

Ken HoexterBank of America Merrill LynchManaging Director

Great. Good morning. Pat, maybe just — I don’t know if this is Pat or Jeff — but your insight into the congestion — there were a lot of questions on congestions already, but how do you get ahead of that? Jeff, you mentioned you want to turn the cars faster, put cars online, not just the Mexico numbers you put up there, but cars online overall are at all-time highs and dwell remains high. You’re adding locomotives, but I just want to understand — haven’t we learned that adding assets isn’t really the long-term answer?

I guess going back to Allison’s question, do you need to overhaul the network and how you’re operating it to try to get more efficient? Is there something that significantly needs to change so we don’t keep coming up with these congestion issues every couple quarters? Just to understand how you view operations in terms of what’s going on in the congestion and cars on line continually being a sticking point.

Jeff SongerExecutive Vice President and Chief Operating Officer

This is Jeff. Do we need to do anything macro level to the system? No. Targeting these areas of congestion — Monterrey has been in the past and is right now a source of congestion, but as I mentioned, the investment in Sanchez to relieve that, we’ve got a lot of additional capacity we’ve added there. Our ability to make the operational changes we’ve envisioned as we move on here into Q4 and next year should provide some of the benefit we’ve been anticipating.

This year, the last couple quarters signaled the importance of the rail network. As we talk about our interchange and congestion to move from Texas to now Mexico, I see inventories — take Sanchez, for example, we’ve cut those inventories in about half since the peak now. So, I feel much better that as inventory in cars to specific terminals move out that we can regain our normal operation and flow traffic between those terminals, flow traffic from the north now to the south because we have receiving capacity, for example, with Sanchez.

Ken HoexterBank of America Merrill LynchManaging Director

Mike, when you’re talking inventories, you’re talking car traffic in your yards?

Jeff SongerExecutive Vice President and Chief Operating Officer

Overall cars on line. If you look at our total cars on line, there are a couple drivers for that. One is just cycle times, cars needing to move faster. Overall car volumes are still elevated in the US trying to get south now. This smoothing of the network is what we have to have happen. The resiliency of the rail network and creating and eliminating congestion and not just moving this congestion back and forth across the bridge, it’s dependent on the resiliency of the entire US and Mexico network. So, those are the things we’re working on, those are the things that led to some of the elevated inventories we saw going into this congestion.

Patrick J. OttensmeyerPresident and Chief Executive Officer

I’d also go back to what we said earlier, Ken. That is things like working with UP, working on developing a longer-term strategic role for Brownsville-Matamoras, resourcing that gateway properly to be able to play more was more of a strategic goal for both of us as opposed to go back to the phrase lead valve. That, I think, is an important part of that.

Particularly at the border, recognizing that more than half of our traffic at the border is interchanged with UP just working very closely with them as they work through their own operational changes and making sure we’re in sync with those. The level of communication at all levels including the CEO level with UP as we work through this is very high. It has to be. Most of the traffic we interchanged at the border is going to and from them.

Adding asset, that incapacity at Sanchez, we talked about adding capacity, we’re not going to talk specifically, but go back and reinforce — adding capacity at customer sites to handle some of the traffic that has historically congested our yards and improve cycle times for certain customers is a big contributing factor as well.

Jeff SongerExecutive Vice President and Chief Operating Officer

I would highlight one more example. When we look at our refined products terminals — as Brian mentioned where we’re at today, which will certainly improve when tanks are up and running next year, if you look at cars online, private car tanks is one example, because we’re still running some of that in manifest, because we’re still transloading, those cars are still remaining on our network for an elongated period of time.

It may take us two weeks to unload a unit train in the Salinas terminal right now, whereas we get into next year, the tanks are there, additional capacity has provided those cars are going to turn a lot more rapidly. I think I can’t just look across the entire segment without separating here are issues or here is additional elevated volumes because of tank cars or car hoppers for some of the similar issues capacity and some of these investments will continue to help out with.

Ken HoexterBank of America Merrill LynchManaging Director

I’m glad to hear some sense of urgency. It just seems like that’s what’s going to help with your rapid growth. It still seems like a lot of pinch points holding cars on line at those high levels. If I could follow-up, there was just a question on crude — I just want to understand your view, Pat, on crude.

We heard from the carriers up north. They’re hesitant in taking too much crude and really limiting it given not only their fear of overdoing the available capacity but really ensuring they’re getting return knowing it’s going to disappear in three years. So, in three years or so, if you’re going to have another one of what’s going on in coal, where it massively just disappears, I want to understand how you view crude by rail in terms of how much you want to take on given some of the capacity constraints you’re talking about.

Patrick J. OttensmeyerPresident and Chief Executive Officer

Very much in sync with what I heard from CP yesterday. I listened to their call. We’re approaching it very, very similar in terms of the way we’re thinking about commercial arrangements to make sure we don’t suffer from extreme volatility in that business and resource ourselves to the point where it doesn’t sink up with the commitments we have from customers.

Operator

Our next question comes from the line of Scott Group with Wolfe Research. Please go ahead with your question.

Scott GroupWolfe ResearchManaging Director

Hey, thanks. Good morning, guys. I know it’s been a few years since you’ve given this to us, but last time you reported it, the OR in the US was right around 70. Can you tell maybe tell us directionally where we are today — mid-60s, high 60s, 70? Even if you don’t want to talk specifically about OR, where we stand today, do you think there’s any structural reason why it shouldn’t be just as good as everybody else? If that’s the case, is that something that you’re focused on, shrinking that gap?

Patrick J. OttensmeyerPresident and Chief Executive Officer

I’ll take the last question, absolutely. Are we focused on shrinking the gap? Yes. Do we think we can continue to show improvement in operating ratio? Yes. Absolutely. We’re spending a lot of time looking at — we compare ourselves to our fears. We looked at dozens, if not more, cost and performance categories on a regular basis.

We looked at how are we performing versus the peers versus the best in class versus the industry. What’s the dollar value of that gap? Is there any kind of structural or other reason we can’t be best in class? In some cases, we are. Is there any reason we can’t be average? Probably hard to accept why we can’t be average. Then looking at what’s the dollar value of closing those gaps, what are the initiatives responsible to close those gaps? Who’s accountable for it and what’s an appropriate timeframe to think about it?

So, we have that methodology where we look at ourselves and compare ourselves to our peers and try to develop that framework of gaps, targets, individuals, timeframes, and accountabilities to close those gaps. I’m very confident we can continue to show improved operating ratio performance following that disciplined and focused methodology.

Scott GroupWolfe ResearchManaging Director

Just so we can try and understand the opportunity, can you talk directionally where we are today in the US?

Michael UpchurchExecutive Vice President and Chief Financial Officer

No, we don’t report those separately, Scott. The only requirement that has reporting it separately was subsidiary debt that we had down at KCSM level. When we moved that up to the consolidated level, we basically were relieved of that obligation. We look at this as one big long network with an interchange point at the border. We’re going to manage this as one business.

Scott GroupWolfe ResearchManaging Director

Okay. That’s fair. Can you just help me think about fourth quarter moving parts here? Typically, earnings are flat to maybe down a little bit. There’s moving parts with incentive comp, maybe some of the service costs going away, anything to help us calibrate models would be helpful, Mike.

Michael UpchurchExecutive Vice President and Chief Financial Officer

Yeah. I think response to Chris’ question, I gave a little bit of guidance on the expense side, up a bit in depreciation with PTC, a little bit of an increase in comp. We would expect fuel prices to continue to go up. Jeff talked about the locomotive leases adding a little over $1 million. Typically, fourth quarter revenue topline is lower than third quarter.

The third quarter is typically the best quarter. You get a lot of manufacturing facilities that shut down in mid-December. Given that we were shy of where we expected in the third quarter, maybe that makes the comp go sequentially a little bit easier. Generally, maybe this year will be somewhere in the flat range on revenue.

Operator

Our next question is coming from the line of Justin Long with Stephens. Please proceed with your question.

Justin LongStephens — Analyst

I wanted to start with a question on peak season. I’m curious what you’ve seen in your network in terms of the pull forward of freight ahead of tariffs and if you strip out any impact from a pull forward. Have you seen anything in the underlying demand environment that gives you pause related to inbound volume at the ports, particularly from China or are you still expecting this to be a pretty robust and strong peak season?

Brian HancockExecutive Vice President and Chief Innovation Officer

Hi, Justin. This is Brian. We are very pleased with the way the peak season has come in the third quarter at the beginning of the fourth quarter. I will tell you we saw a little bit of a pull-up in our intermodal business and specifically in the steel area there before the tariffs. That was more the July August timeframe. So, we’re already in the number. We feel very comfortable that it’s going to continue.

All signs from our customers are that there’s significant growth in each one of the key areas that would drive that. If you look back at 2018 in the first quarter, we thought out intermodal volumes would drop off. They did not. Everything we’re seeing and hearing is the trucking shortage will continue. We will be ahead of where most of the forecasts are on automotive. Like Mike said, we are happy to lap our coal shutdown. We’re ready for that. I would say overall we’re very comfortable going into next year that our .

Justin LongStephens — Analyst

Anything you can give us on the contribution in 2019 would be helpful as well. Thank you.

Brian HancockExecutive Vice President and Chief Innovation Officer

We will always point you toward their website and their communications on that as to when they’ll ramp up. We feel very comfortable with the way that we planned it. In accordance with them, we’ve got our plans into 2019. I think they said they’ll continue to ramp up in the fourth quarter.

It will be slow ramp in 2019, but we feel very comfortable that the businesses that we support will be up and running and we’ll already start to see some of those volumes here in the late fourth quarter, but also, I think you’ll continue to see that ramp up into 2019. Plastics is going to continue to be a slow roll across all of the railroads, I think, as you see ports and different ports and different flows than there have used to be with regard to the resins, but we’re going to see strength in that for the next few years as all these plants come on line.

Operator

Our next question is coming from the line of Brian Ossenbeck with J.P. Morgan. Please proceed with your question.

Brian OssenbeckJ.P. Morgan — Analyst

Good morning. Thanks for getting me on here. Two follow-up questions — when you look at the volumes coming down significant, Brian, could you give us some of your exposure , if there’s any way to pivot that into other areas as the in-basin starts to take more share.

Brian HancockExecutive Vice President and Chief Innovation Officer

Yeah, Brian. That’s certainly come down significantly faster than we thought it would. The white sand out of the Great Lakes area has really slowed down. In-basin, the brown sand has continued to be used more and more. We believe that will continue. Where it will actually level out, we’re not exactly sure. We’re pretty sure the white sand is going to continue to slow down. From an exposure perspective, it will really depend on where we see the balancing between the two. I would expect to see brown sand continue to be utilized more in that Texas region and the white sand will drop off as it continues.

Brian OssenbeckJ.P. Morgan — Analyst

All right. Then just going back to refined products — the after-tax income, the administrative has supported some commentary about possibly change that to keep the inflation rate more in line with overall inflation. So, I just wanted to get your thoughts on that, if you hear anything similar what the producers and shippers are telling you on that and how it would affect the market and the specific credit you have from that mechanism.

Brian HancockExecutive Vice President and Chief Innovation Officer

Yeah, Brian. I’ll start this and tag-team this with Mike. I would say from a refined products perspective, the new administration has been extremely engaged in this area. They are concerned about storage. They are concerned about refining capacity. We’ve been engaged with them in understanding how we can support better utilization of their current refineries, helping them in developing storage, how they price that in the market and how they look at that.

They’re going through a learning process right now on how that all goes from a pricing perspective. We’re going to let them sort through that. We feel very comfortable that they’re engaged and continuing with Mexico energy reform. They realize that to keep their economy growing, they’ve got to have additional storage. They’ve got to have additional sources. Quite frankly, the Gulf Coast and the refineries there are perfect spots to feed that volume. We’re going to continue see significant volume growth. From a pricing — I’ll let Mike take that one.

Michael UpchurchExecutive Vice President and Chief Financial Officer

Well, Brian, if you’re asking what’s the impact of potentially moving up or down IEPs to our fuel expense, I think it’s pretty clear that the current administration has used the opportunity to lower IEPs to try to manage the increase in fuel costs in Mexico. It’s hard to say exactly what the new administration might do when they take office later this year, but I guess I continue to view IEPs as if it lowers the credit maybe a little bit lower for us, but we’ll also be saving that in the purchase of fuel. We don’t have to pay that. It should essentially be a net wash to us.

Brian OssenbeckJ.P. Morgan — Analyst

Our next question is from the line of Brandon Oglenski with Barclays. Please proceed with your question.

MattBarclays — Analyst

Good morning. This is Matt on for Brandon. Just looking at your automotive business. Looking out, we see in your investor presentation that production is up. We see some estimates that put it maybe more in the flat to even down range. Just broadly, do you think you’ll be able to outgrow the market from here and what gives you confidence in the outlook of the automotive business?

Brian HancockExecutive Vice President and Chief Innovation Officer

I would say our automotive business continues to be strong. We had several opportunities this year to pick up share, which we did. Will we outgrow the market? Production is going to continue to grow as forecast. Our expectations are and I think that 2018 has been in line with that, that we will exceed the production increases that are planned.

We do believe we’re picking up share in some of the key facilities, but we also believe we’ve created some unique service offerings for some of our largest customers that have allowed us to pick up that share. We’re continuing to look at how do we create unique opportunities, unique service offerings that allow them to meet their goals, and at the same time, getter better utilization across the railroads. So, I think we’ll continue to see strength in our automotive business.

Michael UpchurchExecutive Vice President and Chief Financial Officer

Matt, this is Mike. Just about share, if you look at the third quarter results, we were up in the automotive segment and our competitor in Mexico was actually down. I think that’s been true most of the year. I think the takeaway there is we probably are taking some share.

MattBarclays — Analyst

Thank you for the color. Following up, could you clarify a little on your comment around flat revenue in the fourth quarter, sequentially?

Michael UpchurchExecutive Vice President and Chief Financial Officer

Well, don’t read too much into that. My comment was generally speaking, from a seasonal standpoint, you would expect fourth quarter revenue to be lower than third quarter revenue. This year, obviously, our third quarter revenue could have been a lot higher had we operated the network efficiently. But going into the fourth quarter, kind of look at it maybe as flat revenues from 3Q to 4Q. Maybe we’re a little bit above that. We’ll just have to see.

Operator

Our next question comes from the line of Jason Seidl with Cowen and Company. Please proceed with your question.

Jason SeidlCowen and CompanyManaging Director

Thank you, Operator and thanks for taking the time this morning, gentlemen. I want to touch base a little bit on some of your commentaries about the lack of logistics investment historically in Mexico. Given that we’re sitting here on the precipice of NAFTA 2.0, how should we look at foreign direct investment and what are the long-term implications for the growth.

Brian HancockExecutive Vice President and Chief Innovation Officer

Jason, this is Brian. I made that comment. What I would tell you is I think companies are becoming smarter in understanding that logistics infrastructure is essential when you build a facility. You can look at the two major auto facilities that were created this year. Both of those, a big part of the construction has been what is the logistics infrastructure necessary to support this facility.

So, you think about storage, you have trucking storage, rail storage. What I would tell you is most of that design work was not done. If you think about the manufacturing facilities that were built in the 80s and 90s in Mexico, right after the North American Free Trade Agreement as put in, I would say logistics was not the primary concern.

I would say now, those companies look at those investments in the steel industry, automotive, grain, as Pat mentioned. They’re looking for, “How do I get better utilization of my assets?” They realize once the asset is in, the largest cost they have is infrastructure from a logistics perspective or a logistics expense.

So, they’re putting in additional track. You see people putting in loop tracks. You see them putting in large storage yards for trucking. What I would say is Mexico is developing. They’re evolving. When you think about logistics infrastructure, we’re just a big part of that, a big facilitator of the rail infrastructure, but also helping these big manufacturers and these big CPG companies, if you will, create infrastructure that allows them to be more efficient at their plants and not just a low-cost manufacturing hub, but a real fulfillment mindset inside of these facilities.

It takes time, but I would tell you at least the two or three big facilities that have been built over the last two years, every single one of them has incredible rail and truck infrastructure that just wouldn’t have been present ten years ago.

Jason SeidlCowen and CompanyManaging Director

That’s great color, Brian. So, this is more of a mindset and not necessarily a NAFTA thing, but NAFTA is probably not going to hurt it.

Brian HancockExecutive Vice President and Chief Innovation Officer

Absolutely.

Patrick J. OttensmeyerPresident and Chief Executive Officer

I think the other thing is and Brian hit on this — if you think about new auto plants, those facilities are being built right out of the gate with adequate, the new facilities that we worked with, they’re doing that right at the very beginning. Where we see room for improvement and room to possibly invest or co-invest with some of our customers to create better logistics efficiencies are in some of the older facilities like grain and steel that weren’t built initially with that logistics and storage capacity.

So, that’s been a source of congestion in our yards. It’s been a source of delays in cycle times or extended cycle times. So, we’re trying to go in to some of those older facilities and fix them so that we have more of a balance. Grain is probably a great example. Most of our grain facilities are unit shuttle loaders.

So, we can load 110 or 120-car train very efficiently. Then we take them down into Mexico and they’re broken up into 25-car blocks with congestion in our yards and congestion in main line and all that kind of thing. We’re trying to fix those facilities so that we can create those efficiencies for some of the older facilities we serve.

Your question about NAFTA and USMCA, NAFTA is gone, remember, and direct foreign investment, the thing that’s interesting over the last couple of quarters in spite of the uncertainty of the trade agreement, direct foreign investment has continued to be pretty strong. We think the removal of this cloud of uncertainty — remember, we’ve got to get it through congress in all three countries yet, but the removal of that uncertainty we certainly see as being positive in foreign investment in Mexico going forward.

Operator

Thank you. The next question comes from the line of Tyler Brown with Raymond James.

Tyler BrownRaymond James — Analyst

Hey, good morning, guys. Hey, Mike, can you update us on your cash tax-paying status post the tax reform. I think the guilty provisions and basically the NOLs — so, I think you paid like $50 million in cash taxes last year. I’m curious what you think you’ll pay this year and how that trends over the next couple and basically, when do you think you’ll be a full cash tax payer?

Michael UpchurchExecutive Vice President and Chief Financial Officer

We’re going to trend up being a cash tax payer. We have been paying cash taxes in Mexico for a while. We’ll pay some in the US. I would probably guide you somewhere in the low 20s to 24%-25% range.

Tyler BrownRaymond James — Analyst

Okay. Perfect. I’m not sure if this is for Pat or Mike. I hate to picky here, but what exactly is going on at the PCRC? It looks like it lost money this quarter versus something like a $20 million below the line annual benefit at its peak. Basically, what’s going on there. Is this the canal having some structural impairment of that business or am I reading into it too much?

Patrick J. OttensmeyerPresident and Chief Executive Officer

No. I think they had some difficulties with a couple customers, losses, some business. I think we’ll get through it and should start to see a reversal of some of those trends in the future.

Michael UpchurchExecutive Vice President and Chief Financial Officer

Tyler, just to be clear, it’s not just PCRC that’s in those numbers. Venture down into TSCM is included in that, the terminal operator in Mexico City, FTBM that we have a 25% ownership interest in is also included there. So, it’s not just PCRC but yes, there are businesses definitely down.

Operator

Thank you. Our next question comes from the line of Mike Baudenstiel with Stifel. Please proceed with your question.

Mike BaudenstielStifel Financial Corporation — Analyst

Thank you. I just wanted to ask you — UP received a letter from the STB regarding potential service concerns from changing the operations with the precision scheduled railroading. History tells us that could lead to some service issues near-term, getting worse before getting better. Do you share those concerns and is there anything you can do to make sure they can remain an effective interchange partner?

Patrick J. OttensmeyerPresident and Chief Executive Officer

We’re staying on our toes. UP, what they have said publicly is they’re going to go about this in a different way than some of their peers, but all I can say is we’re on our toes. We’re staying very close to them so that we anticipate and we can prepare and plan for any changes in behavior that we’ve come to expect or that we’ve seen in the past as they make their transition to a different model. Communication level is very, very high, as I said earlier, at all levels with UP right now.

Mike BaudenstielStifel Financial Corporation — Analyst

Got it. I just wanted to ask you — you said core pricing came in at 3.7%. Is there a forward-looking metric there that you can provide of renewals?

Michael UpchurchExecutive Vice President and Chief Financial Officer

I would tell you the 3.7% is a good metric. We feel good about the pricing. This is a great pricing environment. We’re going to continue to see strong pricing opportunities in Mexico and US. We’re going to take advantage of that where we can and we feel very comfortable, especially in the mix that we see happening, the changes that we’re going to be very positive in the pricing space. So, we feel pretty comfortable that we’ll stay very close to this type of pricing here into the near future.

Operator

Thank you. There are no further questions at this time. Mr. Ottensmeyer, I’d like to turn the floor back to you for closing comments.

Patrick J. OttensmeyerPresident and Chief Executive Officer

All right. I can’t think of anything left unsaid at this point. Thank you for your time and attention. We will talk to you again in about three months. Thank you.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. I thank you for your participation.

Duration: 89 minutes

Call participants:

Patrick J. OttensmeyerPresident and Chief Executive Officer

Jeff SongerExecutive Vice President and Chief Operating Officer

Brian HancockExecutive Vice President and Chief Innovation Officer

Michael UpchurchExecutive Vice President and Chief Financial Officer

Allison LandryCredit Suisse — Analyst

Tom WadewtizUBS — Analyst

Chris WetherbeeCitigroup — Analyst

Matt RussellGoldman SachsAnalyst

Bascome MajorsSusquehanna International GroupAnalyst

Amit MehrotraDeutsche BankAnalyst

Ken HoexterBank of America Merrill LynchManaging Director

Scott GroupWolfe ResearchManaging Director

Justin LongStephens — Analyst

Brian OssenbeckJ.P. MorganAnalyst

MattBarclays — Analyst

Jason SeidlCowen and CompanyManaging Director

Tyler BrownRaymond James — Analyst

Mike BaudenstielStifel Financial Corporation — Analyst

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